Profit and Loss Account – Complete Guide for Commerce Students
🧾 Author: Amrut Ashok Chitragar
📅 Published on: January 17, 2023 at 09:20 AM
🔄 Last Updated: August 4, 2025
📌 Disclaimer: This article is for educational purposes only. It does not constitute financial, tax, or legal advice. Readers should consult a qualified professional before making decisions based on this content. All efforts have been made to ensure accuracy, but we are not responsible for any errors or omissions.
🎓 Learn With Amrut Most Repeated Interview/Exam Question Click here to view
1️⃣ What role does the Profit & Loss Account play in financial reporting?
It reflects the operational outcome of a business — showing whether it earned a net profit or incurred a loss over a defined period.
2️⃣ Why are only indirect items posted in the Profit & Loss Account?
Because direct items like purchases or stock are already adjusted in the Trading Account to derive Gross Profit.
3️⃣ How is depreciation treated and why is it essential in the P&L Account?
It’s shown as an indirect, non-cash expense that ensures realistic asset valuation and profit reporting.
4️⃣ Where does the net result of the P&L flow in final accounts?
Net Profit or Loss is transferred to the Capital section in the Balance Sheet to reflect owner’s equity impact.
5️⃣ Can you give the formula to arrive at Net Profit?
Net Profit = Gross Profit + Indirect Incomes − Indirect Expenses (excluding capital items).
A Profit and Loss Account shows how much profit a business made over a period by comparing income and expenses. Students must understand its structure, formats, and how it connects with Trading and Manufacturing Accounts.
- 1. What is a Profit and Loss Account?
- 2. Key Components of a P&L Statement
- 3. Formats of Profit and Loss Account
- 4. Direct vs Indirect Items in Accounting
- 5. Capital vs Revenue Items
- 6. Interesting Fact Box
- 7. Shortcut Format (Learn With Amrut Style)
- 8. Steps to Prepare a P&L Account
- 9. Trading Account vs. Profit and Loss Account
- 10. Sample Journal Entries for P&L
- 11. Preparing P&L Using Tally and Excel
- 12. Study Tips for Commerce Students
- 13. Frequently Asked Questions
- 14. Real-Life Use Case: Bakery Owner & Missing P&L
- 15. Conclusion
- 📚 Recommended Books
Introduction
In 2008, when I used to prepare Profit & Loss accounts manually, we would start by posting transactions through vouchers and then open individual ledger accounts to reflect these entries. After that, I would prepare the Trial Balance by classifying all transactions into revenue and capital expenditures, incomes, and finally, tallying it with the Balance Sheet. That process had a unique charm—there was joy in understanding each ledger effect and watching how the numbers connected.
If you're new to Profit and Loss concepts, I recommend reading the foundational articles I’ve written earlier:
These articles provide the background needed to fully grasp how entries flow into the Profit & Loss Account.
📌 During that time, I remember one moment clearly— when I was still learning, my sir once went for an assessment visit. A senior officer there casually asked him, "Why is the Opening Stock shown in the Trading Account?"
This moment reminded us how basic accounting clarity is still missing even at high levels.
My sir, taken aback, smiled politely. He didn't blame the officer, but later explained to us how such confusion arises due to a lack of deep accounting knowledge and understanding of correct ledger effects.
This memory still stays with me and reminds me of the importance of solid fundamentals.
Today, much of that workload is automated with accounting software. A simple voucher entry now lets the software do the rest. While this saves time, it sometimes limits the learning process—especially for new accountants who may not fully grasp how ledgers impact financial reports or why classifications matter. This generation, growing up with automated tools, risks missing out on the foundational accounting logic that builds true financial insight.
This detailed guide simplifies the concept of the Profit and Loss (P&L) Account, a crucial financial statement used to determine whether a business is making money or losing it. Targeted at commerce students and aspiring professionals, this guide uses everyday examples and practical tools such as Excel and Tally to make learning easier and more relevant.
1. What is a Profit and Loss Account?
A Profit and Loss Account (P&L) is a financial report that shows the total income and expenses of a business during a specific period...
2. Key Components of a P&L Statement
| Component | Meaning | Example |
|---|---|---|
| Revenue | Total earnings from business activities | ₹1,00,000 from sales |
| Direct Costs | Costs directly tied to production/sales | ₹40,000 for raw materials |
| Gross Profit | Revenue – Direct Costs | ₹60,000 |
| Indirect Costs | Overheads not related to production | ₹25,000 |
| Net Profit | Gross Profit – Indirect Costs | ₹35,000 |
Mnemonic Tip: R → D → G → I → N
3. Formats of Profit and Loss Account
🅑 T Format (Traditional Ledger Style)
| Dr. (Expenses) | Amount (₹) | Cr. (Incomes) | Amount (₹) |
|---|---|---|---|
| To Rent | 8,000 | By Gross Profit b/d | 50,000 |
| To Salaries | 12,000 | By Interest Income | 3,000 |
| To Net Profit transferred to Capital A/c | 33,000 | ||
| Total | 53,000 | Total | 53,000 |
🎯 T Format vs Vertical Format – When to Use
VERTICAL FORMAT (P&L STATEMENT) Sales Revenue ₹1,20,000 Less: Opening Stock ₹15,000 Add: Purchases ₹45,000 Add: Direct Wages ₹20,000 Less: Closing Stock ₹10,000 ------------------------------------------------- COGS (Cost of Goods Sold) ₹70,000 ------------------------------------------------- Gross Profit ₹50,000 Less: Rent ₹8,000 Less: Salaries ₹12,000 Add: Interest Income ₹3,000 ------------------------------------------------- Net Profit ₹33,000
4. Direct vs Indirect Items in Accounting
| Type | Description | Example Ledger Names |
|---|---|---|
| Direct Income | Income from core business activities | Sales A/c, Job Work A/c |
| Direct Expense | Expenses related to production or services | Wages A/c, Freight Inward, Power A/c |
| Indirect Income | Income not directly tied to operations | Rent Received, Interest Income |
| Indirect Expense | General office/admin expenses | Rent A/c, Telephone A/c, Salaries |
📌 Note: Only indirect items are shown in the Profit & Loss Account. Direct items go into the Trading or Manufacturing Account first to arrive at Gross Profit.
5. Capital vs Revenue Items
| Type | What It Means | Appears In | Why Not in P&L |
|---|---|---|---|
| Capital Expense | Cost of acquiring or improving long-term assets | Balance Sheet | Not a routine expense; provides future benefit |
| Capital Revenue | Income from sale of fixed assets or investments | Balance Sheet | Not earned from regular operations |
| Revenue Expense | Day-to-day operational costs | Profit & Loss Account | Part of recurring operations |
| Revenue Income | Income from business activities | Profit & Loss Account | Earned during normal course of business |
📌 Reminder: Capital items affect the long-term financial health of a business, while revenue items affect the current year’s profit or loss. Mixing the two leads to accounting errors and wrong financial decisions.
6. Interesting Fact Box
In the pre-GST era, taxes like MODVAT and CENVAT were routed through the Profit & Loss Account to show excise duty impact on cost and profitability.
7. Shortcut Format (Learn With Amrut Style)
Let’s revise using a simple formula:
- Revenue (A): ₹1,00,000
- Direct Expenses (B): ₹40,000
- Gross Profit (C) = A – B = ₹60,000
- Indirect Expenses (D): ₹25,000
- Indirect Income (E): ₹2,000
- Net Profit = C – D + E = ₹37,000
8. Steps to Prepare a P&L Account
- Record revenue sources (e.g., sales, services)
- List direct expenses (materials, wages)
- Calculate Gross Profit = Revenue – Direct Costs
- List indirect expenses (e.g., rent, admin salaries)
- Compute Net Profit = Gross Profit – Indirect Costs
- Format the final Profit & Loss Account in Excel, Tally, or accounting software
9. Trading Account vs. Profit and Loss Account
| Comparison Point | Trading Account | Profit & Loss Account |
|---|---|---|
| Focus | Direct income & direct costs | Indirect income & expenses |
| Purpose | Calculates Gross Profit | Calculates Net Profit or Loss |
| When Prepared | Before Profit & Loss Account | After Trading Account |
| Financial Report | Part of Final Accounts | Part of Final Accounts |
10. Sample Journal Entries for P&L
Here are some typical journal entries that affect the Profit & Loss Account, presented in a Tally-style format:
| Transaction | Journal Entry |
|---|---|
| Rent paid ₹5,000 | Rent A/c Dr ₹5,000 → To Cash A/c ₹5,000 |
| Sale made ₹20,000 | Cash A/c Dr ₹20,000 → To Sales A/c ₹20,000 |
| Salary paid ₹8,000 | Salary A/c Dr ₹8,000 → To Cash A/c ₹8,000 |
| Telephone bill ₹1,000 | Telephone A/c Dr ₹1,000 → To Bank A/c ₹1,000 |
| Net Profit transferred to Capital A/c | Profit & Loss A/c Dr → To Capital A/c |
📌 Note: If there is a net loss, the same entry applies, but the Capital A/c is reduced.
11. Preparing P&L Using Tally and Excel
You can prepare the Profit & Loss Account using either accounting software like Tally or manually using Excel. Here's how to approach both:
📊 In Tally:
- Navigate to: Gateway of Tally → Display → Profit & Loss A/c
- Ensure all voucher entries are correctly entered and updated
- Tally automatically generates Gross and Net Profit based on ledger classifications
📈 In Excel:
- Create two separate columns: Income and Expenses
- Use a formula like:
=SUM(Income) - SUM(Expenses) - Apply basic formatting: totals, borders, color codes
- Add simple charts for visual representation of financial performance
12. Study Tips for Commerce Students
Mastering the Profit & Loss Account becomes easier when you apply concepts to real-life situations. Here are some tips to improve your understanding:
- Use your family's monthly budget to simulate income and expense statements
- Practice using college fest expenses and sponsorships as business cases
- Watch animated tutorials or online CA Foundation lectures for visualization
- Work with classmates to create dummy accounts in Excel or notebooks
- Download and read annual reports from listed Indian companies to analyze real P&L data
- Join commerce forums or Telegram groups where mock questions are shared
- Recreate a business scenario (e.g., bakery or tuition center) and prepare its books manually
📌 Pro Tip: Don’t just read — simulate and create your own Profit & Loss format to understand how numbers flow!
14. Real-Life Use Case: Bakery Owner & the Missing P&L
Imagine a small bakery owner in Bengaluru who deposits both personal and business earnings into the same bank account. At the end of the financial year, his Chartered Accountant faces difficulty identifying true business profitability. Why?
Because without a separate Profit and Loss (P&L) account, there’s no clear record of:
- ✅ How much was spent on raw materials like flour or eggs
- ✅ How much revenue came from actual sales vs personal transfers
- ✅ Whether salaries paid to staff were properly tracked
When a structured P&L is maintained:
- 📉 Tax liability is minimized with proper expense classification
- 🏦 Bank loan approvals become smoother due to clear profitability
- 📊 Owners understand profit vs cash in hand, improving decisions
❓ Why Many Small Business Owners Avoid P&L Accounting
Despite these benefits, many micro and small traders do not prepare a Profit & Loss Account. Here’s why:
- 🔸 Lack of Awareness: They think P&L is only for big businesses or GST filings.
- 🔸 Mixed Accounts: Personal and business expenses are merged in one bank account.
- 🔸 No Accountant: They rely on memory or pocket notebooks instead of proper ledgers.
- 🔸 Fear of Tax Notices: Some believe keeping records will attract scrutiny.
- 🔸 Focus Only on Daily Cash: They assume if cash is left, business is doing fine.
🧾 Insight: Even basic monthly accounting using Excel or Tally can protect small business owners from tax issues and improve decision-making.
13. Frequently Asked Questions (Student & Google Searched)
📘 A. Student FAQs (Conceptual & Exam-Oriented)
| Student Question | Answer |
|---|---|
| Why are only indirect items shown in the P&L Account? | Because direct items are recorded in the Trading Account to calculate Gross Profit. |
| What’s the journal entry for net profit transfer? | Profit & Loss A/c Dr. → To Capital A/c |
| Is commission income direct or indirect? | It's an indirect income unless your main business is commission-based. |
| What if the P&L Account shows net loss? | It reduces the capital account and should be investigated. |
| How are prepaid expenses treated in P&L? | They are shown as assets on the Balance Sheet, not current-year expenses. |
🔍 B. Most Google-Searched P&L Questions
| Google Question | Answer |
|---|---|
| What is the difference between Trading and P&L Account? | Trading Account calculates Gross Profit using direct items. P&L shows Net Profit using indirect items. |
| Why is depreciation included in P&L? | It's a non-cash, indirect expense that spreads asset value over its useful life. |
| Which items are exclusive to the P&L Account? | Indirect incomes (e.g., interest) and indirect expenses (e.g., rent, admin). |
| Where is Net Profit transferred? | It is transferred to the Capital Account and reported in the Balance Sheet. |
| How is Net Profit calculated? | Net Profit = Gross Profit + Indirect Income − Indirect Expenses |
🔎 People Also Search For
✅ Two formats: T-Format (Ledger Style with Dr/Cr columns) and Vertical Format (Modern P&L presentation). Both are shown in this article with sample figures.
✅ You can generate it using Tally or Excel. Tally auto-generates P&L from voucher entries. In Excel, build a two-column sheet and use formulas to show Net Profit.
✅ Net Profit from the P&L Account is transferred to the Capital section of the Balance Sheet at period end.
✅ Create two columns (Income and Expenses), calculate totals, and use basic formulas like
=SUM(). Format rows clearly and highlight Gross & Net Profit.
✅ Start with revenues, subtract direct costs (COGS), then subtract indirect expenses to get Net Profit. Follow the steps provided in Section 8 of this article.
✅ It is a nominal account – used to record all indirect expenses and incomes for a specific accounting period.
✅ Refer to the T-Format and Vertical Format examples in this article where a ₹53,000 Net Profit is calculated step-by-step.
✅ The Trading Account comes first (for Gross Profit), then the P&L Account follows (for Net Profit). A comparison table is provided in Section 6 & 9.
Conclusion
The Profit and Loss Account is a mirror of business performance. Students should master its logic before jumping into software. For professionals, it helps with decisions, planning, compliance, and financial confidence. It’s not just an academic concept—it’s a real-world tool that impacts business success.
📚 Recommended Books
- Double Entry Bookkeeping – T.S. Grewal
- Financial Accounting – P.C. Tulsian
- Accountancy Class XI & XII – D.K. Goel
- CA Foundation Accounting Module – ICAI
💬 Message from the Author:
Dear students,
I’m completing 18 years in the accounting field, and here’s my Guru Mantra to all of you:
“Learn the subject deeply by blending traditional manual methods with today’s tech tools. Accounting isn’t just numbers—it’s clarity, ethics, and logic.”
Stay curious. Stay practical. And remember—software may speed up your work, but manual understanding builds mastery.
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